BHP Billiton keen on selling new image but investors yet to buy it

TWO of the world's top 10 companies, BHP Billiton and Apple, delivered big announcements this week. The resource giant produced a staggering $US23.6 billion ($A22.50 billion) profit and Apple said its founder and mastermind, Steve Jobs, would be stepping down as chief executive.

The companies deserve their spots on the market capitalisation ladder, but they have nothing in common, other than what they produce is in high demand. Where they sit on this league table in, say, five years will be testament to their ability to read their markets. The immediate response to the resignation of Jobs was a more than 5 per cent fall in the Apple share price - this despite people waiting for this shoe to drop for a year. The success of Apple has been a story of innovation and marketing that is without peer - products that sometimes copied, usually refined but always captured the imagination of the consumer.

The sustained earnings growth from a company that relied on innovation is in itself highly unusual. But it was this constant improvement that earned it a valuation to put it at No. 2 in the world measured by market capitalisation.

BHP Billiton, by contrast, is not a company that has needed to reinvent the wheel. But over the past five years it has been blessed by having mineral resources that are in acute demand from a number of developing economies, including China. For the most part the booming profit growth that BHP Billiton is experiencing is built on legacy assets built over decades. The growth in demand for these resources has not yet been matched by supply and in some sectors such as iron ore and coal this may not happen for another five or 10 years. The major investment in supply has been a relatively recent occurrence.

BHP and arch rival Rio Tinto have now engaged in large-scale capital expenditure to boost supply but it will be a few years before this comes on stream. BHP took advantage of a conservative balance sheet to continue investment during the global financial crisis but has since stepped this up. Thus the bulk of BHP's bloated cash flow comes from improved prices for its products rather than much of an increase in the volumes sold.

The issue for BHP is that the price-earnings ratio on which it trades does not reflect a market view that this great fortune can go on without risk. Investors are concerned that if China's growth falters, the company might also deflate. BHP argues that it now has a more reliable source of income, given that its portfolio of commodities is more diverse. It wants to market itself as an industrial company dressed in a commodity company's clothing. And here is why. Iron ore made up 68 per cent of Rio's earnings before interest, tax, depreciation and amortisation - for BHP it made up just 37.5 per cent.

The company says the linear nature of its dividends - they are stable or increase - is evidence of its earnings sustainability. That it continues to invest during the cycle further backs up this position. BHP also employs some degree of capital management and has bought back shares. All strategies are used to iron out the cyclicality of a typical commodity business. BHP takes the view that China will become less reliant on export earnings as demand from its middle-class continues to pick up, and that this will be aided by breaking the long-held pattern of excessive saving as middle-class welfare systems such as healthcare and superannuation emerge.

China's current phase requires raw materials such as iron ore and coal to make steel, and this will move into demand for middle-class products such as whitegoods. As Asian and Latin American economies continue to develop, so will their requirements for energy and protein. The BHP map involves investing across these assets to accommodate each new stage.

It's fair to say that despite the grand plan to put capital into counter-cyclical investments, BHP is viewed as a stock whose massive returns are the result of the high prices it now receives, primarily for its iron ore. The company's share price fall from more than $49 four months ago to yesterday's close of $38.61 suggests the market is responding to fears that BHP remains hostage to the fortunes of the skittish broader international economy.